Arizona Court of Appeals Division One Holds That (1) a Trial Court Does Not Err in Failing to Impose a Constructive Trust on Property When There Is No Connection Between the Defendant’s Breach of an Agreement and the Defendant’s Acquisition of Rights to the Property, and (2) a Trial Court Does Not Have Discretion to Refuse to Award Attorneys’ Fees to a “Prevailing Party” in Litigation When a Mandatory Contract Provision Applies.

Murphy Farrell Development, LLLP (“Murphy Farrell”) and a group of related entities owned and ran a cattle ranch north of Congress, Arizona.  In the late 1990s, John Murphy, principal of Murphy Farrell, decided that the ranch land could also support a business for harvesting decorative rocks and boulders.  Murphy formed Rock Resources, Inc. for that purpose.  Rock Resources employed Clay Sourant to locate areas within or near the ranch for harvesting rock.  Sourant left Rock Resources in the late 1990s to strike out on his own.

Sourant acquired rights from Santa Fe Pacific Railroad and the State of Arizona to harvest rock from, and access land near, the ranch.  There was one wrinkle in Sourant’s deal with Santa Fe Pacific – he believed he was acquiring 320 acres, but the legal description on the quit claim deed encompassed only 240 acres (the “Mineral Land”), omitting an 80-acre area (the “Omitted Parcel”).  In May 2000, Sourant, Murphy Farrell, and Rock Resources entered into an agreement (the “May Agreement”) granting Murphy Farrell, among other things, the right to harvest rock from the Mineral Land and the right of first refusal to a thirty acre parcel (the “Quarry Property”) in exchange for royalty payments to Sourant.  The May Agreement used the same legal description used in Sourant’s deal with Santa Fe Pacific, but inaccurately described the Mineral Land as 320 acres.

Two months later, Sourant acquired additional rights from Santa Fe Pacific.  In July 2000, Sourant and Murphy Farrell entered into another agreement (the “July Agreement”) under which Sourant assigned his surface mineral rights to 450 acres near the ranch in exchange for advance royalties.  Sourant also agreed not to compete with Rock Resources for five years.  In May 2006, ten months after the covenant not to compete expired, Sourant acquired from Santa Fe Pacific the mineral rights to an additional 850 acres, including the Omitted Parcel.

Eventually, disagreements arose concerning Sourant’s performance under the two agreements, and Murphy Farrell filed suit, seeking damages and equitable relief.  Before a three-day bench trial, Murphy Farrell requested, pursuant to Arizona Rule of Civil Procedure 52(a), that the trial court enter findings of fact and conclusions of law.  The court found that Sourant had breached the May Agreement by failing to afford Murphy Farrell the right of first refusal to the Quarry Property, and that Sourant had breached the July Agreement by offering to assist another company to acquire mineral rights near the ranch during the period of the non-compete agreement.  The court also concluded, however, that Murphy Farrell was not entitled to the constructive trust it requested, and because Murphy Farrell had dropped its request for monetary damages, the court entered judgment in Sourant’s favor.  Both parties appealed.

Murphy Farrell argued on appeal that the trial court erred in failing to address issues related to the Omitted Parcel and the Quarry Property.  With respect to both parcels, the Court of Appeals concluded that the trial court should have explicitly addressed the related issues because the issues were raised in the parties’ joint pretrial statement and because Murphy Farrell had requested findings of fact and conclusions of law pursuant to Rule 52(a).  The Court of Appeals refused to address these issues in the first instance, however, instead remanding to the trial court to address these issues.

Murphy Farrell also argued that the trial court erred in refusing to impose a constructive trust on the 850 acres Sourant acquired from Santa Fe Pacific in May 2006 as a remedy for Sourant’s breaching the covenant not to compete in the July Agreement by offering to assist another company to acquire mineral rights near the ranch.  The Court of Appeals disagreed.  It noted that, for a constructive trust to be an appropriate remedy, “[a]t a minimum, . . . the plaintiff must have an equitable interest in the property wrongly held by the defendant to give rise to the defendant’s duty to convey that property to the plaintiff.”  And, “because there is no connection between Sourant’s breach of the covenant and his purchase of the 850 Acres, Murphy Farrell has no equitable interest in that property, and a constructive trust is not an available remedy.”

The Court also rejected Murphy Farrell’s other arguments related to the constructive-trust remedy.  Murphy Farrell argued that Sourant also breached the covenant not to compete by contacting Santa Fe Pacific’s mineral rights broker shortly before the covenant period expired to inform the broker of Sourant’s interest in acquiring additional mineral rights, which led to his eventual acquisition of the 850 acres.  This argument failed, however, because the trial court found that Sourant’s contacting the broker did not constitute a breach of the covenant, and Murphy Farrell did not challenge this finding on appeal.  In any event, the Court of Appeals concluded that this contact would not justify a constructive trust because Sourant’s inquiry was not related to any particular parcel and did not give Sourant an advantage over Murphy Farrell with respect to the 850 acres.  Murphy Farrell’s other argument – that the trial court should have imposed a constructive trust on Sourant’s profits from the sale of the Mineral Land to Murphy Farrell – also failed because Murphy Farrell did not raise this claim to the trial court and therefore waived it.

Sourant appealed the trial court’s refusal to award him attorneys’ fees under the May Agreement and the July Agreement, which mandate an award of fees to the “prevailing party” in litigation.  The trial court had denied fees based on its conclusion that Sourant had breached the agreements, reasoning that Murphy Farrell would have been entitled to monetary damages had it not dropped that claim in favor of its constructive-trust theory.

The Court of Appeals noted first that the provisions were not discretionary, and thus the trial court was required to award fees to Sourant if he indeed was the “prevailing” party, leading the Court to ask the question, “who won?”  Sourant’s breaches of the agreements did not, the Court said, prevent a finding that he was the prevailing party.  A trial court must “assess the overall outcome of the case” to determine the winner.  In order to do this, a trial court may use the “percentage of success” or “totality of the litigation” methods approved for determining fee awards under A.R.S. § 12-341.01.  The Court instructed the trial court to apply one of these methods on remand after it addressed the issues relating to the Omitted Parcel and the Quarry Property.  The Court of Appeals also instructed the trial court to award the prevailing party with its reasonable attorneys’ fees expended on appeal, but refused to award costs on appeal, finding that neither party was the “successful party” on appeal.

PRACTICE NOTE:  Although Murphy Farrell had failed in its amended complaint to allege that it was entitled to rights in the Omitted Parcel, the parties’ joint pretrial statement listed this as a material issue, thereby effectively amending the complaint and properly presenting the matter for the trial court (and the Court of Appeals) for adjudication.

PRACTICE NOTE:  In a side argument, Sourant argued that Murphy Farrell had no rights in the Quarry Property because the right of first refusal in the May Agreement violated the rule against perpetuities.  The Court of Appeals noted that the trial court implicitly found that the right of first refusal was valid and enforceable by finding that Sourant had breached this provision.  Because Sourant had not challenged this implicit finding on appeal, it was final and served as law of the case on remand.

Judge Timmer authored the opinion; Judges Portley and Gould concurred